An option is a contract that gives its owner the right to buy or sell some asset at a pre-specified price. See Zvi Bodie and Robert C. Merton, Finance, 384 (2000). An option to buy the specified item at a fixed price is a call; an option to sell is a put. The buy or sell price specified in an option contract is called the option's strike price or exercise price. The date after which an option can no longer be exercised is called its expiration date or maturity date. An American-type option can be exercised at any time up to and including the expiration date. A European-type option can only be exercised on the expiration date.
Options on stocks were first traded on an organized exchange in 1973. See John C. Hull, Options, Futures and Other Derivatives 5 (1999) (hereinafter Hull). European and American options on foreign currencies are now actively traded in both over-the-counter and exchange-traded markets. The Philadelphia Stock Exchange has been trading currency options since 1982.
Pricing formulas for call options are known. For example, the Black-Scholes-Merton formula states that the price C of a European-type call option for a stock can be calculated at any time before the option matures by the following:C═SN(d1)−Le−rTN(d1−σ√{square root over (T)}),where S is the current price—the price at which the stock underlying the call option is trading. N(d) is the probability that a random draw from a standard normal distribution will be less than d. d1 is given by the formula:
      d    1    =                    ln        ⁡                  (                      S            E                    )                    +                        (                      r            +                                          σ                2                            2                                )                ⁢        T                    σ      ⁢              T            where S=price of the stock; E=exercise price; r=risk-free interest rate (the annualized, continuously-compounded rate on a safe asset with the same maturity as the option); σ=the volatility of the stock-that is, the standard deviation of the annualized, continuously-compounded rate of return on the stock; T=time to maturity of the option in years; L is the exercise price-the price at which the holder has the right to buy the stock when the call option expires; and e−rT is a term that adjusts the exercise price, L, by taking into account the time value of money.
Other, generally more complicated, formulas exist for option pricing. The nature of the problem dictates that they depend on the probability that the price of the asset will reach a certain level in a certain period of time. This probability in turn is a function of the current asset price and the volatility (current and/or predicted) of the asset price. A high volatility increases the probability than a given asset price will be reached.
As is known to those skilled in the art, options generally and option pricing methods in particular are not user-friendly: novice investors find them arcane and intimidating, and consequently avoid using them.
There is thus a need for a user-friendly, efficient, intuitively simple type of option. Such an option should be sophisticated enough to be interesting to experienced traders, yet user-friendly enough for a novice to use. Similarly, there is a need for a method and system that allows a novice user to create and select the parameters of such an option without needing to understanding the mathematics or financial theory behind the option.